1. School of Banking and Finance www.banking.unsw.edu.au

2. FINS3640 - Investment Management Modeling Week 4 - 11 Aug 2010 Introduction to using Stata for Financial Modeling

3. Revision Stata commands Regression and t-test interpretation R2 P-value Hypothesis testing Null hypothesis H0 Conditional testing Binary Visual plot analysis Price observation, holding period return, dividend and stock split adjustments WRDS

4. Multivariate Models

6. Capital Asset Pricing Model Market Premium

8. Fama-French Three-Factor Model Size Premium Value Premium

10. Four-Factor Model Momentum Momentum-Driven Portfolio Rebalancing

12. Five-Factor Model Asset Growth

15. Generic Multivariate Model This is what you need to build

16. How? Some hints: Read contemporary research (see suggested reading list) Retrieve & process data (in-class demonstration) Establish hypotheses (should be from a quantitative course) Test the hypotheses Correlation R2 & adjusted R2 P-value t-value Other econometrics indicators (chi2, autocorrelation…) Build and optimise the model(s)

18. Modeling

19. Data Management Wharton WRDS French Data Stock selection Monthly 5-30 years

20. Weighting

21. Risk-free Rate CAPM assumption: single risk-free rate Is this practically true?

23. Statistical Testing Multivariate regression t-test Visual analysis

24. Multicollinearity Variables are almost linearly dependent Large standard errors lead to insignificant t-values Little explanatory power Test Collinearity Correlation matrix Rotation of variables: R2 does not change much when one variable is dropped Remedy Drop collinear variable(s)

25. Outliers & Influential Points Extreme values Market crashes e.g. October 1987, PG 2010 Market capitalisation of top firms from highly concentrated indices e.g. BHP from ASX Skews the model 'Black swans' Identify: unusual observations on visual display Remedies Time series method: log normal Exclusion of influential points

27. Andersen T G, Bollerslev T, Diebold F X, Wu G, 2006, 'Realized Beta: Persistence and Predictability', Econometric Analysis of Financial and Economic Time Series, Advances in Econometrics, Volume 20, 1-39, Elsevier, 2006

28. Binary Variables Grouping by

29. Heteroskedasticity White 1980 Run regression reg y x The Het test right after running regression hettest Save the residual predict res, r Plot the residuals plot res x Bibliograph http://www.polsci.wvu.edu/duval/ps602/Notes/STATA/heteroskedasticity.htm http://web.missouri.edu/~kolenikovs/stata/Duke/class3.html http://www.stata.com/support/faqs/stat/panel.html

30. Autocorrelation Autocorrelation ac Partial autocorrelation pac Q-statistics Correlogram corrgram

33. ARIMA Autoregressive integrated moving average arima predict

34. Reading

35. Reading (1) Required Reading Reeves J. J. 2008 Recommended Reading Multivariate Models Louise Swift, Sally Piff, Quantitative Methods for Business, Management and Finance, 2nd edition John Y. Campbell, Yeung Lewis Chan, Luis M. Viceira, 2001, 'A multivariate model of strategic asset allocation' Alvin C. Rencher, 2002, Methods of multivariate analysis

36. Reading (2) Fama French Fama, Eugene F.; French, Kenneth R. (1993). "Common Risk Factors in the Returns on Stocks and Bonds". Journal of Financial Economics 33 (1): 3–56 Fama, Eugene F.; French, Kenneth R. (1992). "The Cross-Section of Expected Stock Returns". Journal of Finance 47 (2): 427–465

37. Reading (3) Momentum Barberis, N., A. Shleifer, and R. Vishny. “A Model of Investor Sentiment.” Journal of Financial Economics, 49, 1998. Crombez, J. "Momentum, Rational Agents and Efficient Markets." The Journal of Psychology and Financial Markets, 2, 2001. Daniel, K., D. Hirschleifer, and A. Subrahmanyam. “A Theory of Overconfidence, Self-Attribution, and Security Market Under and Over-reactions.” Journal of Finance, 53, 1998. Jegadeesh, N., and S. Titman. “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency.” Journal of Finance, 48, 1993. Jegadeesh, N., and S. Titman. “Profitability of Momentum Strategies: An Evaluation of Alternative Explanations.” NBER Working paper #7159, 1999.

38. Reading (4) Asset Growth Cooper, Gulen & Schill, 2009, 'The asset growth effect in stock returns' Business Cycle DeStefano, Michael, 'Stock Returns and the Business Cycle'. Financial Review, Vol. 39, No. 4, November 2004 Corporate Governance Shane A. Johnson, Ted Moorman, and Sorin Sorescu, 2005, 'Governance, Stock Returns, and Market Efficiency'

39. Reference Reeves J. J. 2008 Andersen et al 2006 Heng et al 2010 http://www.polsci.wvu.edu/duval/ps791c/Notes/Stata/arimaident.html